Accounting Standards

A number of countries and institutions have adopted accounting
standards developed by the AAOIFI, which are designed to complement the International Financial Reporting Standards.
The IFSB aims to promote the development of a prudent and transparent
Islamic financial services industry and provides guidance on the
effective supervision and regulation of institutions offering Islamic
financial products. The IFSB has recently finalized standards on capital
adequacy and risk management, and has made progress in developing
standards on corporate governance. Once developed and accepted, these
international standards will assist supervisors in pursuing soundness,
stability, and integrity in the world of Islamic finance.

Liquidity Management

Another issue concerns the design of Islamic instruments for monetary
operations. In countries with a dual banking system, the lack of
non-interest bearing securities has limited the scope of monetary
management. The liquid nature of banks’ liabilities, related to
the predominance of deposits of short-term maturities, predisposes the
system to hold substantial liquid assets and excess reserves.
This, in turn, inhibits financial intermediation and market deepening.
Difficulties in defining rates of return on these instruments have also
constrained the development of money and interbank markets.

Developing these markets is indispensable for the conduct of monetary
policy and financial market deepening. The inadequate development
or absence of these markets in many countries constrains central bank
intervention through indirect instruments and has occasionally
encouraged the use of direct controls on credit. The absence of
well-organized, liquid interbank markets, that can accept banks’
overnight deposits and offer them lending to cover short-term financial
needs, has exacerbated banks’ tendencies to concentrate on short-term
assets. Effective liquidity management requires the adoption of a
comprehensive, integrated approach to developing money and securities
markets.

Areas for future development

Other issues include the lack of aggregate data making it virtually
impossible to compare Islamic banks across countries, which, together
with the absence of common reporting and accounting standards,
complicates the work of supervisors.

The markets for Islamic instruments and government securities remain
shallow and an organized international Islamic financial market is still
nascent. The sector must improve the range and sophistication of
asset and liability classes and develop new instruments and financial
techniques that would enable Islamic banks to diversify their balance
sheets.

Finally the adoption of a common position on certain financial
instruments would help develop Islamic finance and improve its
competitiveness globally. For example, a number of issues relating
to speculation and the use of derivatives must be resolved before a
fully functioning Islamic stock market can evolve. While arbitrage and
short selling are not acceptable under Shari’a, other financial
transactions appear to be, in practice, subject to varying
interpretations. For instance, transactions involving the purchase and
sale of debt contracts in secondary markets are permissible only in
Malaysia.

The Future

The Islamic financial services sector should continue its recent
compound annual growth for some time to come. It is a valuable addition
to the more conventional, Western, style of financial services. Because
of the nature of the products issued, it should also have some appeal
beyond the Muslim community and some of its products could well be
adopted by the financial community at large.

There are, however, many issues to be faced. Most of these issues are
related to the relative immaturity of the market and the steep learning
curve being faced by all participants in the market: the
institutions, the regulators (including the interpreters of
Shari’a) and the consumers, many of whom are uncertain of which
products may comply with their interpretation of Shari’a.

For the foreseeable future, supervisory authorities will continue to
face the dual challenges of understanding the industry and striking a
balance between providing effective supervision and facilitating the
industry’s legitimate aspirations for further growth and
development. These conditions would create a level playing field
and provide the infrastructure needed for the industry’s market-driven
development. A sound, well-functioning Islamic financial system
can pave the way for the regional financial integration of the countries
involved. It can also contribute to their economic and social
development, by financing the economic infrastructure and creating job